Commission Splits, Kickbacks, and Referral Fees

Nancy Neighbor refers a plum listing to Andy Agent. Andy is considering sending a "gratuity" to Nancy. Andy knows Nancy fancies champagne, and Andy has found a couple of bottles of Krug's Clos du Mesnil 1995 for a mere $750 per bottle, and he contemplates giving her some.

Agnes Agent has a plum listing, and Benjamin Buyer made an offer that the owner countered. Benjamin Buyer responds with a counteroffer that requires Agnes to kick back part of her commission as "non-recurring closing costs."

Are these commission splits, or referral fees, legal? What if they are labeled as "reimbursement of non-recurring closing costs," will that make a difference? Although these fee split arrangements are somewhat common and are often legal under California law, many people would be surprised to learn that they can be illegal under federal law in the Real Estate Settlement Procedures Act ("RESPA")1.

First let's examine State law. Under California law a broker can pay compensation only to another broker or to a duly licensed salesperson through the employing broker. Even if someone is otherwise entitled to a commission split, if they are unlicensed at the time the compensation is earned it is illegal to compensate that person. It is illegal for a broker to employ or compensate an unlicensed person for acts that require a license.

Payment to someone employed by the broker to perform clerical services or other office functions is not illegal. However, if that person performs services requiring a license, such as answering questions about a listing, promoting a property, or holding an open house, it may be a violation.

Also under California law a broker can share a commission with a party to the transaction, provided that person is not doing any work that would require a license.2 While this seems to make it OK to split a commission with the buyer or seller, a moment's consideration suggests situations where the line becomes less distinct. For example, what if the buyer writes up his or her own purchase offer containing a request for a portion of the commission. Would not the drafting of the purchase offer be an act requiring a license?

The same holds true of payment of a finder's fee. There is no prohibition under California law so long as the finder does not perform any services requiring a license. A finder is someone whose only act is introducing a prospective buyer or seller to one another or to an agent. Several cases have defined a "finder" this way; "The finder is a person whose employment is limited to bringing the parties together so that they may negotiate their own contract, and the between the finder and the broker frequently turns upon whether the intermediary has been invested with authority or duties beyond merely bringing the parties together, usually the authority to participate in negotiations." 3

In one case a broker made an agreement with a landlord to receive a commission if the broker found a tenant. The broker offered an attorney a third of his commission if the attorney introduced him to a tenant. The attorney made the introduction, but remained tangentially involved in the lease negotiations, communicating terms between the parties and advising the landlord. The court held that the attorney had performed acts for which a license was required, and voided the commission agreement as being illegal.4 In other cases where the finder did not participate in the negotiations or transaction the payment of a finder's fee has been upheld.

The California Attorney General issued an opinion in 1995 that a broker can pay a referral fee to an unlicensed person for a referral so long as the referring person was not soliciting on behalf of the broker.5 The opinion goes on to say that the finders fee exemption can apply only if the finder's activity is limited to the introduction, and the finder is not involved in any role in the negotiations "no matter how slight."

The matter is different under federal law. RESPA covers most transactions involving singlefamily residences in properties of one to four units. RESPA provides that, "No person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person." 6 Most loans are "federally related" because that includes not only loans made by federally insured lenders (almost all banks are insured by the FDIC), but also loans intended to be sold to a federal institution such as Freddie Mac or Fannie Mae.

This prohibition applies to both licensees and laypersons. Realtors® are not exempt. RESPA prohibits either giving or receiving any consideration or thing of value pursuant to any agreement or understanding that it is in exchange for referral of business relating to a real estate settlement.

What is a "settlement?" The definition found in RESPA is long-winded and difficult.7 Paraphrasing, "Settlement Services" are defined as anything relating to a real estate settlement (close of escrow) including anything relating to title searches, examinations, or insurance, services rendered by an attorney, preparation of documents, credit reports, appraisals, pest control activities, services rendered by a real estate agent or broker, and almost anything having to do with a mortgage loan from a federally insured institution, such as taking the loan application, loan processing, underwriting or funding.8

RESPA goes on to prohibit the giving or accepting any portion, split, or percentage of any charge relating to a settlement service other than for services actually performed. Thus if someone did not actually do work to earn the kickback or comission split, it is likely that payment to them will be illegal.9

The highly regarded real estate law treatise by Miller & Starr, California Real Estate, citing RESPA, concludes, "The Act does not prohibit a cooperative brokerage and referral agreement between real estate brokers where one broker pays a referral fee to another broker.[FN9] However, a broker cannot pay any consideration to an unlicensed finder even though such payment may be legal under state law." 10

The California Department of Real Estate's Mortgage Loan Bulletin, Spring 2006, states, "Section 8(a) of RESPA11, . . . , and its implementing regulations12 . . . , prohibits giving and receiving any fee, kickback, or thing of value for the referral of settlement service business. Things of value are broadly defined under RESPA's rules and include monies, trips, an opportunity to win a prize, free advertising, stock in a company, etc. Some examples of prohibited practices are: . . . Real estate agents or mortgage brokers paying "finders fees" to friends and past customers for referring new business."

A violation of RESPA carries the potential for up to a year in jail and a $10,000.00 fine for each involved party. Additionally an affected consumer can bring a civil action for damages three times the amount of any charge paid that violates RESPA, plus attorney fees and court costs. Authorities differ in their opinions of what does and does not constitute violations of either state or federal law. Also slight differences in the facts can affect the outcome. This article is a general discussion and is not intended to address any specific situation. It is best to stay on the conservative side, and if in doubt contact a knowledgeable real estate lawyer for guidance.
by Real Estate Attorney Peter Brewer